Crummey Trusts offer excellent tools for passing on wealth without gift or estate taxes and, for those generous grandparents out there, without generation skipping transfer taxes.
I. PURPOSE
To understand the Crummey Trust, you must first understand the annual gift tax exclusion. This exclusion is the amount of cash or other assets one person may transfer to another person as a gift without incurring a gift tax, having to file a gift tax return, or reducing the giver’s unified credit. The unified credit is the lifetime gift and estate tax exclusion amount, which is at an all-time high of $13,610,000 per person in 2024. The Gift Tax Exclusion amount is $18,000 in 2024.
This amount applies per person per year. For example, two grandparents can gift $18,000 each to two grandchildren in 2024, for a total gift of $72,000 without filing a gift tax return and without any estate or gift tax consequence.
The Crummey Trust addresses a particular problem: the annual gift tax exclusion doesn’t usually apply to gifts made in trusts.
The IRS requires the recipient to have a “present interest” in the gift or the exclusion doesn’t apply. Trusts, by contrast, typically give future interests. That is, the beneficiaries of the trust will receive something in the future, long after assets are put into the trust. But generous and wise grandparents don’t want to hand $36,000 to a grandchild who is a minor or young and inexperienced; such grandparents want to gift significant funds to that grandchild in a protected trust.
The Crummey Trust enables donors like those grandparents to give gifts up to the annual exclusion amount in trust while satisfying the IRS’s “present interest” requirement. The resulting gift is complete and thereby removed from the taxable estate of the grantors.
This enables high-net-worth individuals to reduce their taxable estates without impacting their unified exclusion amount. Crummey Trusts also enable grantors to gift assets in trusts that protect those assets from creditors of the grantors and the recipients and from the possible indiscretion and naivety of the recipients.
II. REQUIREMENTS
As you can see, a Crummey Trust isn’t crummy at all – it’s a gift of love from a generous and wise benefactor. So how does it work? Let’s consider the requirements of a Crummey Trust.
Like many requirements concerning trusts, Crummey Trust rules come from a combination of lawsuits and IRS regulations. In a lawsuit between Clifford Crummey and the IRS back in the 1960s, the court ruled that Mr. Crummey’s gifts in trust were not taxable because they fell under the annual gift tax exclusion amount.
A Crummey Trust must be irrevocable, meaning that the grantor cannot change it. A Crummey Trust must be inter vivos, meaning that it is established while the grantor and the beneficiary are alive. The grantor typically funds the trust by transferring into it assets up to the annual exclusion amount each year.
Finally, the Crummey Trust must create a “present interest” in the beneficiary. The Trust accomplishes this by giving the beneficiary power to make annual withdrawals from the trust of the lesser of: (1) the amount of the annual gift tax exclusion; or (2) $5,000 or 5% of the trust assets, whichever is greater.
The Trustee of the Crummey Trust must send a notice to each beneficiary after the establishment of the trust and each contribution to that trust. If the beneficiary is a minor, the trustee sends the Crummey Letter or Notice to the beneficiary’s guardian. The notice provides the beneficiary with at least 30 days to exercise a right to withdraw the most recent contribution.
The IRS will not allow any agreement or “prearranged understanding” with the beneficiary not to make the withdrawal. However, the grantor and the beneficiary typically do have an informal understanding. If the beneficiary decides to make the withdrawal anyway, the grantor can stop making contributions in future years. Otherwise, no distributions are necessary at any age, and the grantor can decide how the funds in the trust will be distributed, as with other types of trust.
III. CRUMMEY TRUSTS FOR GRANDCHILDREN
Grandparents seeking to make tax-free gifts to grandchildren will find Crummey Trusts especially useful.
In addition to gifting in trust funds that qualify for the annual gift tax exclusion, Crummey Trusts provide grandparents with an opportunity to qualify gifts for exclusion from the Generation Skipping Transfer Tax or GSTT. The annual GSTT exclusion is like the annual gift tax exclusion: a grantor can gift up to $18,000 in 2024 GSTT-free. This can result in massive tax savings, since the GSTT rate is 40%.
To qualify for exclusion from GSTT, the Crummey Trust must be created for a single grandchild or “skip person” in IRS language, and the trust must be includible in the gross estate of the beneficiary at the beneficiary’s death.
Crummey Trust provisions may be found in more specific types of trusts. For example, Irrevocable Life Insurance Trusts or ILITs use Crummey Trust provisions to qualify annual contributions to the trust for the Gift Tax Exclusion or the GSTT Exclusion. Those contributions are then used to pay the premiums on life insurance policies held in the trust.
IV. INCOME TAXATION OF CRUMMEY TRUSTS
How do Crummey Trusts pay income tax?
The Crummey trust can be and often is structured as a Grantor Trust. The Grantor pays income tax on a Grantor Trust under the Grantor’s social security number. By paying the income tax, the Grantor enables the trust to accumulate value tax-free. This effectively is an additional gift to the beneficiaries without estate or gift tax consequences.
After the Grantor’s death, the Crummey Trust will be treated as a separate taxpayer with its own Taxpayer Identification Number or TIN. Undistributed income will be taxable to the trust, and income distributed to the beneficiary will be taxable to the beneficiary.
Crummey Trusts must be drafted carefully because in some cases the holder of the right to withdraw might be taxed on trust income.